WASHINGTON — Federal Reserve Chair Jerome Powell said the Treasury Department’s efforts to replenish the government’s coffers will likely draw deposits out of the banking system.
Speaking after Wednesday’s Federal Open Market Committee meeting, Powell said the Fed will be “monitoring markets carefully” as the Treasury issues $425 billion of short-term securities this month to ensure the process does not destabilize the banking system.
Powell said the debt issuance, which is aimed at rebuilding the Treasury General Account at the Fed, will “very likely” lead to the reduction of other assets on the central bank’s balance sheet, including facilities for lending securities to money market funds and cash from commercial banks, known as reserves. Yet, he said, he does not anticipate the process leaving banks wanting for liquidity.
“We are starting at a very high level of reserves and a still-elevated [overnight reverse repurchase agreement] take up for that matter, so we don’t think reserves are likely to become scarce in the near term or even over the course of the year,” Powell said. “We will, of course, continue to monitor conditions in money markets and we’re prepared to make adjustments to make sure that monetary policy transmission works.”
The Fed aims to maintain an “ample supply” of reserves to protect its ability to set monetary policy. If reserves become scarce, banks tend to bid up borrowing costs beyond the Fed’s target range. The concern with an expansion of the TGA is that it will cause depositors to pull money out of their bank accounts to buy Treasuries, thus reducing the supply of reserves.
During the debt ceiling standoff, in which Treasury could no longer issue securities, the TGA fell from $560 billion on February 1 to $44 billion on June 7, as the government drew down funds to pay its bills.
Powell noted that some portion of the funds to replenish the Treasury General Account will come out of the overnight reverse repurchase agreement, or ON RRP, facility, in which participants — mostly money market funds — borrow securities from the Fed then agree to sell them back the next day at a higher price. That facility has been running in excess of $2 billion for more than a year, causing some to worry that the facility is encouraging funding to migrate away from banks and into higher-yield mutual funds, but Powell pushed back against that characterization.
“The RRP doesn’t look like it’s pulling money out of the banking system,” Powell said. “It’s actually been shrinking here lately.”
Powell said the Fed has not considered changing the rate it pays to money market funds that use the ON RRP — a policy measure some have suggested in light of the program’s increased usage — but he did not rule out exploring that option at a later date.
“It’s a tool that we have. If we want to use it, we can,” he said. “There are other tools we can use to address money market issues, but I wouldn’t say that’s something that’s likely that we would do in the near term.”
Powell also addressed other potential risks to the banking sector, including underperforming commercial real estate loans.
Powell said these types of loans are well distributed throughout the banking system, so he does not expect a sudden downturn in office performance to be broadly disruptive. But, he noted, some small banks are heavily exposed to this type of lending and in danger of significant losses. The problem is unlikely to be destabilizing, he said, but it could linger for a long time.
“We’re well aware of that and we’re monitoring it carefully,” he said. “It feels like it feels like something that will be around for some time, as opposed to something that will end up being a systemic risk.”
Powell added that the Fed remains on the lookout for additional ripple effects from the trio of bank failures this spring. He said there are signs that the crisis has caused credit conditions to tighten, but it remains unclear to what extent and what that pullback means for the overall lending environment.
“It’s too early still to try to assess the full extent of what that might mean,” he said. “If we were to see what we would view as significant tightening beyond what would normally be expected … we would factor that into … making rate decisions.”
During the meeting, the FOMC voted unanimously to hold the Fed’s benchmark interest rate steady for the first time in more than a year, signaling a new, more cautious phase of its campaign to tamp down excessive inflation.
The target range for Fed’s federal funds rate will remain between 5% and 5.25% for at least the next six weeks. But, contrary to some pre-meeting speculation, most Fed leaders expect to raise rates at least once more before the end of the year.
Only two of the 18 FOMC participants — which includes members of the Fed’s Board of Governors and presidents of the 12 regional reserve banks — believe the federal funds rate has reached its terminal level for the year, according to the committee’s quarter summary of economic projections.
Four FOMC participants think the target range will be raised by another 25 basis points before the year is done, while nine believe an additional half-percentage point of tightening is in order. The highest projection calls for rates to go above 6%.
This month’s projections show the FOMC favoring a more aggressive approach to dealing with inflation than it did three months ago. In the committee’s March survey, 14 of 18 participants said they did not expect rates to surpass 5.5% this year.
Powell also shot down the idea that a rate cut should be expected before the end of the year, a projection put forth by some market participants in the days and weeks leading up to Wednesday’s meeting.
“Not a single person on the committee wrote down a rate cut this year, nor do I think it is at all likely to be appropriate to think of that,” he said. “Inflation has not really moved down. It has not, so far, reacted much to our existing rate hikes, and so we’re gonna have to keep at it.”